UNG Hasn't Changed the Laws of Natural Gas Supply and Demand

Proof ETFs Can't Manipulate Natural Gas Prices

U.S. Natural Gas (UNG), a controversial exchange-traded fund indexed to natural-gas futures, said August 12th, although it received regulatory clearance to register an additional 1 billion shares, the ETF's management has decided the fund won't resume issuing shares for now, according to a filing Wednesday.

The Government Is Here to Help (late as always)

In explaining the move, management cited "current and anticipated new regulatory restrictions and limitations that have been and may be imposed by the Commodity Futures Trading Commission" and commodity exchanges.

The ETF has seen its assets surge to more than $4 billion, fueling speculation the fund is pushing natural-gas prices higher. Higher? The fund grew so fast that earlier this summer it was forced to halt the creation of new shares while it waited for regulatory approval to increase the number of shares outstanding.

Ok, let's get this straight, "speculators" plowing in tons of money into UNG are driving up NG prices? So, why are NG prices struggling to stay above $3.50 mcf?
Sorry Charley...bad logic. Over the last six months every "Speculator" looking to buy UNG (betting prices would rise) has found plenty of "speculators" looking to sell UNG. I've successfully traded around the NG prices and the UNG ETF hype.

The Natural Gas Facts Minus The Hype

Here are the facts minus the 'bull' and government 'speculator' hype: At the March bottom UNG was trading for around $15.50. By the end of April UNG had fallen (along with NG prices) to $12.73. In May the improved economic indicators pushed the NG hype along with UNG up to $17.50. Four months later; after clear economic improvement and another 1,000 points added to the DJIA... UNG (today) is struggling to stay at $12.70. At this moment in history watching daily NG price changes is as exciting as watching corn grow in Iowa.
click to enlarge

Unlike oil, which has doubled in price, NG is struggling just to hold a $4 mcf price. Investors and speculators' in NG are learning Oil prices are impacted by international economies and now move inversely to the value of the dollar. NG has little correlation to the value of the dollar. Unlike Oil, NG Prices are tethered to American supplies and inventories. If you recall the 2005 price spike over $14 mfc that was due to supply disruptions from Hurricane Katrina which resulted in massive shut-ins of natural gas production.

Natural Gas prices are depressed for Three good reasons:

1) Decreased industrial demand as a consequence of the recession in the United States;

2) Higher supplies from imports of liquefied natural gas (up almost 4x since 2002);

3) Gigantic new supplies coming to market from the shale plays.

The United States has a total resource base of 1,836 trillion cubic feet (tcf) worth of likely and potential resources, the report says, a sharp jump from the last estimate two years ago of 1,321 tcf, and the highest in the group's 44-year history! With the addition of Energy Department estimates of proven reserves, the total U.S. future supply is 2,074 tcf, a rise of more than 35 percent from the committee's last biennial estimate. www.nytimes.com/gwire/...

New Shale Supplies Will Keep Prices Below $6 MCF in 2009:

The latest NG storage figures shows supplies are up over 23% from last year and nearly 20% above the last 5 year average.

Given the flood of new USA NG supplies, just discovered in the last 4 years, forget the historical relationships between NG and Oil. I've even listen to a few analyst who believe NG prices could drop to $3 mcf given the current supply and demand ratios. Remember, for most of the 90's NG prices stayed close to $2 mcf. But if you believe in an improving economy I doubt investors getting into UNG (now) under $12.75 will be hurt. I'm not pounding the table on NG or UNG only viewing it as a current trading opportunity.

The wild card opportunity is: high global oil prices and environmental concerns should force America to wake up to the fact that NG is clean, abundant, cheap and a secure source of energy.

Disclosure: I took a long position in UNG today.

Comments

[H. T. Love:]

On Aug 13 05:08 PM NGAnalyst wrote:

><snip>
> Couple of coments/questions:
> 1. NGU9 is down 4% today, but UNG only 1%. Can anybody explain why?

Since UNG won't (previously couldn't) issue new units, there is no longer an unlimited supply. Dealers can no longer buy "creation baskets" (except those that may have been redeemed previously) in unlimited quantities to satisfy demand. Dealers are now in the boat with us retail investors, to some degree.

So UNG is now the same as a regular stock in many regards - a limited quantity trading in the market. The price suppression that may have occurred by an influx of an unlimited number of shares no longer occurs.

Dealers still have one edge - they can buy when the market is down (NAV higher than market) and then redeem at NAV - a "redemtion basket".

> I think that the two things are already different beasts with reasons
> including --- UNG can only seek gas "proxys" as CFTC limits its direct
> futures holdings &amp; UNG is starting to behave like a "close-end"
> fund as there won't be new shares. For this reason, even though I
> think NG prices will probably still be soft, I bought some UNG today.

Not too bad, but you likely paid a premium of NAV +5% (as of last evening). If it gets to the low $12s, as I suspect, that would be when to buy some more, to reduce your cost. I suggest you then wait for the normal intra-month rise (anytime around/above $13.50) and go short some calls or long puts to make some $ and get a little protection.

>
>
> 2. There is a potential problem with UNG to watch, though --- with
> front futures contract continuously going lower, the contango is
> steeper, which means larger rolling losses.

Yes, this has been noted often on SA many times by others. In fact, this A.M. the difference in prices would dictate that UNG own 9% fewer (plus additional loss from "friction") "contracts" if nothing changed between now and completion of the roll.

HardToLove

Aug 14 11:00 AM

[H. T. Love:]

Thanks for the time and effort. I'm about convinced. But being an obnoxious "understand and think about what you've just learned" type, I'll now go put on a pot of coffee and ruminate on what you shared.

Agai, my thanks for the reply - sharing from knowledgeable folks helps speed my very long and steep learning curve!

HardToLove


On Aug 13 04:22 PM Elliott wrote:

> On Aug 13 02:59 PM H. T. Love wrote:

Aug 14 11:08 AM

[Maxe Paul:]

It's just soooo funny, 99 out of 100 stocks are going up nearly every day, even complete garbage such as toxic banks have risen 100's of percent.

But what do people really want to buy? They want NG, the only commodity that has not gone up, is not going up, dose not even look like going up.

Nope, instead of buying nearly any (rising) stock or commodity, people just want to buy NG and complain it's not going up.

INCREDIBLE!

Aug 14 11:27 AM

[H. T. Love:]

On Aug 13 04:58 PM William M. Wright wrote:

> H.T. thanks for providing the additional educational information
> and responding to the MCF question and providing more proof evil
> "speculators" have little ability to manipulate NG prices through
> UNG ETF (my primary point).

Although that was not my purpose, I'm happy to be of service. In truth, I *am* new to all this. I'm agnostic. I'm analytical (by background). I posted because SA contributors and comments have helped me on my path and I feel obligated to contribute as I can.

>
> However I do feel money flows have an impact which I'm sure based
> upon Elliott's prior post (which seem to support a political party

Hm? I don't read that into his comments, but as stated I'm agnostic. I give him the same credit I give you or anyone, until I see evidence that their bias is emotionally derived, rather than good analysis and fact derived.

> talking points) he would agree. But UNG is not the Hunt Brothers
> seeking to control the silver market like the good-old-days.
> And lets look at the other side of the coin Elliott didn't discuss.
> If America didn't have the flood of money pooring into NG energy
> drilling over the last 5-10 years we wouldn't have an excess of supply
> and prices would be higher. Purhaps Elliott never had an economics class?

I'm not the blog police, but those sorts of comments just waste band-width and reduce your stature, in my opinion.

> Still, based upon Elliott's past post I'd confess we would
> be in agreement most of the time. So I hope Elliott comes out of
> the hidden profile closet and writes Articles about his energy views.
> I'll be the first to read them.
><snip>

> H.T. The 20 to 1 rule you recall I believe was created by the young
> analyst entering the business after 2002. An old man like me was
> taught these two rules of thumb....try 40 to 1.

Actually, where I got that was (recall that I said 19 ... maybe 20 by now ...) doing the math.

Somewhere in my comments back when I started trying to learn, a comment from someone linked to an article that showed a historical ratio chart. It was wild, going from as low as 6:1 to about 12.5:1 at that time. Subsequently folks were hollering how NG was destined to rocket up because of the ratio - quoting whichever one they learned - and by then I had heard such terms as "speculation", GS, MS, JPM, ... and I realized the ratio was broken because fundamentals no longer were the predominate determinant.

I did the math and tried to spread the word that the ratio was broken. I didn't want to see folks get burned repeatedly by ... "sell side" folks.

>
> Two Simple Rules of Thumb for those old enough to remember:
>
> 1) One commonly used rule of thumb relating natural gas prices to
> crude oil is the 10-to-1 rule, in which the price of natural gas
> is one-tenth the crude oil price:
>
> PNG = .1 x PWTI ,
>
> where PNG is the Henry Hub price of natural gas in dollars per million
> Btu and PWTI is the price of West Texas Intermediate (seekingalpha.com/symbo...)
> crude oil in dollars per barrel. Under this rule of thumb, a WTI
> price of $20 per barrel would mean a natural gas price of $2 per
> million Btu at Henry Hub, and $50 oil would mean $5 natural gas.
>
>
> Some energy analysts have argued that natural gas really ought to
> trade at the same price per million Btu as crude oil. Because a barrel
> of WTI contains 5.825 million Btu, those analysts have used a 6-to-1
> rule, in which the natural gas price ought to be roughly one-sixth
> the crude oil price:
>
> PNG = .1667 x PWTI .
>
> Under this rule of thumb, a WTI price of $20 per barrel would mean
> a natural gas price of $3.33 per million Btu at Henry Hub, and $50
> oil would mean $8.33 natural gas.

But we both know that value depends on more than just energy content. Infrastructure, supply, demand, number of different uses, transportability, future potential, ...

Until we have commensurates in those factors (esp. supply, demand, infrastructure and transportability), NG can't achive the equivalent value of oil and its derivatives.

It could be helped by a loss of sufficient oil supply. Anyway, the balance of all considerations, as with any valuation process, will determine the ratio and price.

That's what markets are *supposed* to provide for us.

>
> Here is a Texas source for more info from 2005 Dallas Fed Research:
>
> www.dallasfed.org/rese...
>
> Here is another excellent educational article on NG written in April
> by Buck West:
> seekingalpha.com/artic...
>

Thanks for those links. I've book-marked them in my browser.

Thank you for the article and taking the time to respond. Generosity from folks like you help me immensely.

HardToLove

Aug 14 11:58 AM

[mbkelly75:]

I do not use options much but UNG might be a good place for a LEAP right now as opposed to puts and calls. My thanks for the article and all the links in the comments. A very nice education here on NG.

Aug 14 12:11 PM

[Commies are...:]

Can someone explain how the rollover works with UNG? If contango is in play are they not liquidating the contracts at discount? ... and who is buying these contracts at discount?

Aug 14 04:30 PM

[H. T. Love:]

Start here and see if that answers your questions. There's lots of links therein that should cover anything I overlooked.

Keep in mind that UNG is not issueing new units now, so it is trading at a premium even though it's number of held contracts (even this no longer applies as it is doing its thing in OTC swaps now) does reduce at each rollover due to contango and frictional losses.

I've also begun thinking about its future as the question arises how they make money if dealers are not buying baskets and redeeming them. But that's for another time after investigation.

HardToLove


On Aug 14 04:30 PM Commies are people too wrote:

> Can someone explain how the rollover works with UNG? If contango
> is in play are they not liquidating the contracts at discount? ...
> and who is buying these contracts at discount?

Aug 14 05:21 PM

[H. T. Love:]

Before you jump into leaps, ask the question "How will UNG make money if not issuing new units"? I'm not saying anything specific now, just something to think about.

HardToLove


On Aug 14 12:11 PM mbkelly75 wrote:

> I do not use options much but UNG might be a good place for a LEAP
> right now as opposed to puts and calls. My thanks for the article
> and all the links in the comments. A very nice education here on
> NG.

Aug 14 05:23 PM

[H. T. Love:]

RATS AGAIN! FORGOT THE LINK.

seekingalpha.com/artic...


On Aug 14 05:21 PM H. T. Love wrote:

> Start here and see if that answers your questions. There's lots of
> links therein that should cover anything I overlooked.
>
> Keep in mind that UNG is not issueing new units now, so it is trading
> at a premium even though it's number of held contracts (even this
> no longer applies as it is doing its thing in OTC swaps now) does
> reduce at each rollover due to contango and frictional losses.<br/>
>
> I've also begun thinking about its future as the question arises
> how they make money if dealers are not buying baskets and redeeming
> them. But that's for another time after investigation.
>
> HardToLove

Aug 14 05:24 PM

[H. T. Love:]

"1661, if I recall correctly."

Annndddd I didn't recall correctly. The high was 1606!

Why I get it right in one comment and not the other? Typo, yeah, that's the ticket. It was a typo! ;-) (Thx SNL)

HardToLove

On Aug 13 02:28 PM H. T. Love wrote:

><snip>

> One factor to consider, although it's a longer term issue,
> is Baker-Hughes last Friday reported rigs that are now
> at 2002 *average* levels (691/681 - I forget at the
> moment which is which). Off from a high 8/29 and 9/12
> 2009 of 1661, if I recall correctly.

Aug 14 05:35 PM

[Commies are...:]

@ H.T Love

Thanks for the background on UNG !

Took a kicking on HNU (which has the 2x leverage). I'm one of those who played the oil : ng ratio and got carried out in a body bag.

Aug 14 10:51 PM

[H. T. Love:]

To Elliot and William M. Wright

I welcome any corrections or constructive thoughts about what I post below.

First order of business is to thank both of you for taking the time to respond to my prior posts. Those led me to look further into the issues raised.

I thought about the comments from both of you, and fortuitously encountered the article "Do Lawmakers Really Understand Energy Markets" by Hard Assets Investor, which discusses regulation in oil. In there is a nice succinct comment from "derryl" that provides useful input for me.

See these two links.

seekingalpha.com/artic...

seekingalpha.com/artic...

The key for me was the description of the effects of excessive supply and excessive liquidity in causing contango in the futures market. Whether by intent or not, excessive liquidity tends to cause higher prices. In this case the target of the liquidity happens to be futures contracts. Whenever a fixed amount of "goods" (NG) are chased by an excessive amount of money (futures contracts), the tendency is to produce "inflation". I know that we all understand this as a monetary phenomenon. Whether it be in the economy at large or in a particular market, the effects will be the same.

Even though no manipulation was intended by a fund such as UNG, the effect on its underlying is not moderated by that lack of manipulative intent.

The key effect was stated in the two links I provided above. The key effect is in the transmission of false "demand" signals to the producers, via the existence of excessive futures contracts and their prices. True contango has two components - the cost of storage, insurance, etc. to hold the commodity for later sale and a "premium" over and above those costs that offer a profit opportunity to producers (or intermediaries).

As excess liquidity chases the fixed quantity of product available, via purchase of futures contracts, false "demand" signals are generated by higher numbers of purchased futures contracts and their higher prices. This provides the "premium" needed to make the contango. As the producers are in the business of providing a product for profit, they can not initially ignore the signal that there is a demand that will permit an assured profit. As explained in the article and comment, this can only happen when there is an excess supply since a balanced or short supply will cause *immediate* demand, and therefore higher front-month or spot prices, eliminating the contango situation.

But with contango in play the producers dutifully ramp-up and exacerbate the over-supply situation.

The interesting thing is that this causes an illogical situation - initially higher (over) production and *initially* higher prices at the same time, regardless that *true* demand is declining. I think this can continue only as long as an effectively unlimited supply of liquidity is available, such as that provided by UNG and/or the speculators that Elliot mentions in his reply, and an over-supply condition to make a later sale attractive.

Well, one might ask, why have prices of NG continued to decline over the life of the UNG fund? This was the defense that UNG tried to mount via a chart showing declining NG price as UNG ballooned. I see now the answer is not complex.

In the long run fundamentals prevail.

It seems to me that regardless of false demand, elevated futures prices, unlimited liquidity entering the futures market, etc., at some point gas is actually delivered to some customer. The customer can purchase at current spot or front-month contract prices any gas not committed elsewhere. By definition of contango, this price is lower than any out-month futures contract price at the moment of purchase. The customer will purchase at the lower price if not committed to another contract.

Since the customers are buying at a lower price in a recognized over-supply situation, the out-month futures contracts are steadily depreciating as the writers/buyers of the out-month contracts respond to the signals seen from the front of the queue. This is sensible because there is an over-supply of both gas and futures contracts and an effective "shortage" of customers taking delivery, relative to supply, and the out-month folks know that the elevated prices can not hold, based on their current knowledge.

Contracts are only purchased by customers wishing to secure price and delivery, individual speculators wishing to make a profit on the trade and a fund such as UNG which theoretically just wants to track the futures price. These latter two purchasers can not take delivery and so must sell the contracts they hold at some point. Since the contracts are subject to time-decay, there is a possibility that sale may occur under duress. UNG avoids this by rolling out its contracts at pre-determined times, disadvantaging the fund's participants in several ways. Individual speculators do whatever it is that they do.

This means that customers taking delivery are the controlling party in this over-supply situation. Since they will buy only the cheaper spot or front-month deliveries, the other two holders must always end up selling at prices affected by the actions of customers that take delivery.

That means that prices must gravitate towards an equilibrium based on the true supply and true demand, in this case, lower prices. This can really only be prevented if the holders and potential purchasers of the out-month contracts can see a realistic probable re-balancing of the supply in the time-frame of the contracts held.

Elliot poses the question of how low would prices be if the previous speculators and UNG were not in play. The assumption that prices would be even lower is not a given. Remember that the situation we have now is illogical - lower demand, excess supply and a *possibly* higher price than the true demand-supply scenario would suggest is rational. The market function of balancing demand and supply is broken by the presence of excess liquidity, regardless of source. And we can not determine if prices would be lower or higher because the price discovery mechanism of the market is not functioning in this situation. That is, the forces that would normally cause adjustments in production to satisfy normal changes in demand have been suppressed by excessive liquidity. It's natural to *assume* this would mean higher prices, but that really is dependent on the response of the producers sans the excess liquidity. They might overshoot the adjustment, or demand might accelerate as production was being adjusted down or any number of un-anticipated influences could come into play (cap-and-trade anyone?).

If the excess liquidity was not available, excess futures contracts would not be purchased, apparent "demand" seen by producers would be lower and producers would cease excess production much sooner, since there would not be false demand signals. This would tend to bring supply and demand back into balance much sooner, resulting in a *possibly* higher price justified by true demand and supply (im)balance. This is not "illogical", as in the case of the contango situation we presently see.

When UNG's involvement was only a few-hundred million, the effects may not have been substantial. Now that it is $3.9 billion (for details of holdings see www.unitedstatesnatura...) it is more than reasonable to conclude that UNG has distorted the market in two substantial ways:

1. Production capacity was held much higher for much longer than a true normal supply-demand balance would dictate and
2. For some period of time, producers were able to obtain prices above that dictated by a truly normal demand-supply situation.

As a side note, the UNG site tonight shows UNG trading at an 11.32% premium to NAV (closed at $12.49). Normally this starts to correct near the end of roll-out completion (Monday).

HardToLove

Aug 15 02:00 AM

[H. T. Love:]

Yikes! As a new small investor, you can believe I'm truly empathetic. That's why I try and share as I learn and encourage other like me to do the same. The community knowledge is vast. We just need a good Borg cube to get us all tapped into the communal knowledge. ;-)

HardToLove


On Aug 14 10:51 PM Commies are people too wrote:

> @ H.T Love
>
> Thanks for the background on UNG !
>
> Took a kicking on HNU (which has the 2x leverage). I'm one of those
> who played the oil : ng ratio and got carried out in a body bag.

Aug 15 02:20 AM

[dieuwer:]

Why not create a NG fund live SLV or GLD? You can store NG somewhere (as is happening already) and sell shares against the NG holdings.

Aug 17 11:49 AM

[William M. ...:]

H.T. sorry didn't see this post until today. You clearly have a good handle on NG, The Laws of Supply & Demand and UNG.

"In the long run fundamentals prevail" spot on the money. And since no one person knows the future, there have always been "false signals"..."Distorted signals" long before UNG.

But yes, as I believe all three of us would agree it's possible in the "Short Run" for supply and demand to be distored for any number of reasons including "Over Investment Flows"...thats the down side but the part the political talking points never mention is the fact that: "Todays Over Supply And Now 7 Year Low Prices" was the direct result of "Over Spectulation". So when Elliot gets around to opening his NG untility bill this month he should thank the "Spectulators". And as we would all agree NG is not worth debating now. Now the real issue is the price of OIL.

Check out The Day The Oil Bubble Burst on my website:
windowtowallstreet.com...

F.Y.I. I ended up in UNG only 3 days in at $12.65 and stopped out at $12.45. It was a pure speculation play for me based upon prior successful trades in UNG. UNG is now hit a pivot point and new 52 week low @ $11.29 (most of premium is gone). I'm considering another enter here given how UNG works. But not something I want to suggest to others.




On Aug 15 02:00 AM H. T. Love wrote:

> To Elliot and William M. Wright
>
> I welcome any corrections or constructive thoughts about what I post
> below.
>
> First order of business is to thank both of you for taking the time
> to respond to my prior posts. Those led me to look further into the
> issues raised.
>
> I thought about the comments from both of you, and fortuitously encountered
> the article "Do Lawmakers Really Understand Energy Markets" by Hard
> Assets Investor, which discusses regulation in oil. In there is a
> nice succinct comment from "derryl" that provides useful input for
> me.
>
> See these two links.
>
> seekingalpha.com/artic...
>
>
> seekingalpha.com/artic...
>
>
> The key for me was the description of the effects of excessive supply
> and excessive liquidity in causing contango in the futures market.
> Whether by intent or not, excessive liquidity tends to cause higher
> prices. In this case the target of the liquidity happens to be futures
> contracts. Whenever a fixed amount of "goods" (seekingalpha.com/symbo...)
> are chased by an excessive amount of money (futures contracts), the
> tendency is to produce "inflation". I know that we all understand
> this as a monetary phenomenon. Whether it be in the economy at large
> or in a particular market, the effects will be the same.
>
> Even though no manipulation was intended by a fund such as UNG, the
> effect on its underlying is not moderated by that lack of manipulative
> intent.
>
> The key effect was stated in the two links I provided above. The
> key effect is in the transmission of false "demand" signals to the
> producers, via the existence of excessive futures contracts and their
> prices. True contango has two components - the cost of storage, insurance,
> etc. to hold the commodity for later sale and a "premium" over and
> above those costs that offer a profit opportunity to producers (or
> intermediaries).
>
> As excess liquidity chases the fixed quantity of product available,
> via purchase of futures contracts, false "demand" signals are generated
> by higher numbers of purchased futures contracts and their higher
> prices. This provides the "premium" needed to make the contango.
> As the producers are in the business of providing a product for profit,
> they can not initially ignore the signal that there is a demand that
> will permit an assured profit. As explained in the article and comment,
> this can only happen when there is an excess supply since a balanced
> or short supply will cause *immediate* demand, and therefore higher
> front-month or spot prices, eliminating the contango situation.<br/>
>
> But with contango in play the producers dutifully ramp-up and exacerbate
> the over-supply situation.
>
> The interesting thing is that this causes an illogical situation
> - initially higher (over) production and *initially* higher prices
> at the same time, regardless that *true* demand is declining. I think
> this can continue only as long as an effectively unlimited supply
> of liquidity is available, such as that provided by UNG and/or the
> speculators that Elliot mentions in his reply, and an over-supply
> condition to make a later sale attractive.
>
> Well, one might ask, why have prices of NG continued to decline over
> the life of the UNG fund? This was the defense that UNG tried to
> mount via a chart showing declining NG price as UNG ballooned. I
> see now the answer is not complex.
>
> In the long run fundamentals prevail.
>
> It seems to me that regardless of false demand, elevated futures
> prices, unlimited liquidity entering the futures market, etc., at
> some point gas is actually delivered to some customer. The customer
> can purchase at current spot or front-month contract prices any gas
> not committed elsewhere. By definition of contango, this price is
> lower than any out-month futures contract price at the moment of
> purchase. The customer will purchase at the lower price if not committed
> to another contract.
>
> Since the customers are buying at a lower price in a recognized over-supply
> situation, the out-month futures contracts are steadily depreciating
> as the writers/buyers of the out-month contracts respond to the signals
> seen from the front of the queue. This is sensible because there
> is an over-supply of both gas and futures contracts and an effective
> "shortage" of customers taking delivery, relative to supply, and
> the out-month folks know that the elevated prices can not hold, based
> on their current knowledge.
>
> Contracts are only purchased by customers wishing to secure price
> and delivery, individual speculators wishing to make a profit on
> the trade and a fund such as UNG which theoretically just wants to
> track the futures price. These latter two purchasers can not take
> delivery and so must sell the contracts they hold at some point.
> Since the contracts are subject to time-decay, there is a possibility
> that sale may occur under duress. UNG avoids this by rolling out
> its contracts at pre-determined times, disadvantaging the fund's
> participants in several ways. Individual speculators do whatever
> it is that they do.
>
> This means that customers taking delivery are the controlling party
> in this over-supply situation. Since they will buy only the cheaper
> spot or front-month deliveries, the other two holders must always
> end up selling at prices affected by the actions of customers that
> take delivery.
>
> That means that prices must gravitate towards an equilibrium based
> on the true supply and true demand, in this case, lower prices. This
> can really only be prevented if the holders and potential purchasers
> of the out-month contracts can see a realistic probable re-balancing
> of the supply in the time-frame of the contracts held.
>
> Elliot poses the question of how low would prices be if the previous
> speculators and UNG were not in play. The assumption that prices
> would be even lower is not a given. Remember that the situation we
> have now is illogical - lower demand, excess supply and a *possibly*
> higher price than the true demand-supply scenario would suggest is
> rational. The market function of balancing demand and supply is broken
> by the presence of excess liquidity, regardless of source. And we
> can not determine if prices would be lower or higher because the
> price discovery mechanism of the market is not functioning in this
> situation. That is, the forces that would normally cause adjustments
> in production to satisfy normal changes in demand have been suppressed
> by excessive liquidity. It's natural to *assume* this would mean
> higher prices, but that really is dependent on the response of the
> producers sans the excess liquidity. They might overshoot the adjustment,
> or demand might accelerate as production was being adjusted down
> or any number of un-anticipated influences could come into play (cap-and-trade
> anyone?).
>
> If the excess liquidity was not available, excess futures contracts
> would not be purchased, apparent "demand" seen by producers would
> be lower and producers would cease excess production much sooner,
> since there would not be false demand signals. This would tend to
> bring supply and demand back into balance much sooner, resulting
> in a *possibly* higher price justified by true demand and supply
> (im)balance. This is not "illogical", as in the case of the contango
> situation we presently see.
>
> When UNG's involvement was only a few-hundred million, the effects
> may not have been substantial. Now that it is $3.9 billion (for details
> of holdings see www.unitedstatesnatura...)
> it is more than reasonable to conclude that UNG has distorted the
> market in two substantial ways:
>
> 1. Production capacity was held much higher for much longer than
> a true normal supply-demand balance would dictate and
> 2. For some period of time, producers were able to obtain prices
> above that dictated by a truly normal demand-supply situation.<br/>
>
> As a side note, the UNG site tonight shows UNG trading at an 11.32%
> premium to NAV (closed at $12.49). Normally this starts to correct
> near the end of roll-out completion (Monday).
>
> HardToLove

Aug 21 01:58 PM

[Vikram Saxena:]

William,
The problem with UNG is the contango roll costs. You can look up the forward curve for natural gas
finance.yahoo.com/q/fc...

The price for the January '10 is a full $2 above the price of the Oct '09 contract. This a lot more than the same spread next year; Jan '11 is just $1 above the price of the Oct'10. If you go further out, the difference between the Oct and the next Jan contract is even smaller (70-80c). So even if the price of Natural Gas rises in a few months, UNG investors will be short-changed since the forward curve is already pricing in the rise in the price of natural gas.

Since UNG and other commodity funds have become very big players in the futures market the market games them. Plot NGV9-NGU9 and you notice that the spread went up from around 25c to 40c just as UNG was rolling over.

In the short term the market is really depressed because storage is almost full since supply is not diminishing at the same rate as demand, thanks to new shale wells which have very high output initially. The September contract collapsed in pricing as it got close to expiration; there is the same risk even with the October contract. Over the past 4 weeks the spread between October and November contract has widened by almost 30c!

Right now the premium to NAV for UNG is close to 14.2%. GAZ is relatively less pricey though its premium shot up as the news about GAZ not issuing more shares leaked out yesterday.

What we need is a product like USL which has an equal weighted portfolio of contracts spread over an year. Such a fund can capture the structural moves in the pricing of natural gas. Right now UNG is just a proxy of the front month contract.

Aug 22 01:42 AM

[H. T. Love:]

On Aug 21 01:58 PM William M. Wright wrote:

> H.T. sorry didn't see this post until today.

No problem! I hope all of us have a real life too! Many don't bother to check back, so I thank you for that dedication.

I've requested SA to augment their software so we can see when a comment/article we post has activity subsequent to our last action. No word yet - I guess it's too hard.

><snip>

> But yes, as I believe all three of us would agree it's possible in
> the "Short Run" for supply and demand to be distored for any number
> of reasons including "Over Investment Flows"...thats the down side
> but the part the political talking points never mention is the fact
> that: "Todays Over Supply And Now 7 Year Low Prices" was the direct
> result of "Over Spectulation". So when Elliot gets around to opening
> his NG untility bill this month he should thank the "Spectulators".

Folks like to hammer "speculators" while forgetting that the producers who undertake the E&P and related infrastructure expansions are also "speculating". While they speculate on making profit from providing a hard asset, they also speculate on being able to attract capital - financial speculation. If it were not for the financial speculators, *many* deserving efforts in many sectors of the economy would go un-funded.

I think the point of contention is always the very subjective adjective "excessive".

> And as we would all agree NG is not worth debating now. Now the real
> issue is the price of OIL.
>
> Check out The Day The Oil Bubble Burst on my website:
> windowtowallstreet.com...

I'll do that - thanks for the link.

>
> F.Y.I. I ended up in UNG only 3 days in at $12.65 and stopped out
> at $12.45. It was a pure speculation play for me based upon prior
> successful trades in UNG. UNG is now hit a pivot point and new 52
> week low @ $11.29 (most of premium is gone). I'm considering another
> enter here given how UNG works. But not something I want to suggest
> to others.

Still trading at premium to NAV of 14.19%. If you are considering another shot at it, check out my reply to oldtenor here seekingalpha.com/artic....

And do keep in mind that I'm new at this stuff - I know you will.

That comment says, briefly, that UNG is a trade only, you want to use calls and puts to garner some cash while the price slide continues and we look for the transition to a muted seasonally higher price increase and an intersection with switch to backwardation to exit.

Alternately, it is shortable. During the roll-forward, over 60% of the time UNG has a price drop. I have some (outdated now) charts in one of my instablogs that show this.

Thanks for taking the time to get back here. That altruism helps all of us!

HardToLove

Aug 22 11:28 AM

[H. T. Love:]

On Aug 22 01:42 AM Vikram Saxena wrote:

You made excellent points.

><snip>

> What we need is a product like USL which has an equal weighted portfolio
> of contracts spread over an year. Such a fund can capture the structural
> moves in the pricing of natural gas.

United States Commodity Funds, LLC filed for just such an offering 7/6/7, here

www.sec.gov/Archives/e...

and submitted an amended filing 6/18/9 here

www.sec.gov/Archives/e...

I suspect that with the current CFTC actions, this may not come to fruition or may be substantially delayed.

> Right now UNG is just a proxy
> of the front month contract.

And as you highlight, a broken one at that.

HardToLove

Aug 22 11:40 AM

[William M. ...:]

Thanks for the link to the other UNG article. In the past I had little interest in SA but now I see the great thing about SA is the added ability to learn from others and collaborate with smart adults (instead of YAHOOs) .

Understanding the Oil and Gas Industry (and how some producers are hedged) is one skillset and understanding futures contracts is another skillset but understanding how opened ETFs based upon closed end futures contracts in a new regulator hot bed works is frying my simple (over/under valuation risk/reward) brain cells.

Thanks guys, I'll just take the recommendation of my UNG investment committee of Chu, Love and Vikram -and avoid UNG.

Plenty of other sectors and companies and asset allocation decessions to consider no sense me trying to master the rubics cube simply because I got lucky before following a momentum play in UNG. Way to much bad press now.


On Aug 22 11:28 AM H. T. Love wrote:

> On Aug 21 01:58 PM William M. Wright wrote:

Aug 22 04:04 PM

[William M. ...:]

Vikram,

Thanks, while I have very good knowledge of Oil and Gas Industry -Knowing all the ins and outs of an open ended ETF based upon closed ended futures contracts and the mathamatics is a matter best left to electrical engineer's like you. Me I need a Concept Graph in front of my face to get the picture sometimes.

I also agree with all the complaints regarding all the 3x and 2x inverse leverage ETFs. Wall Street will builded any new casino game the public is willing to play.

Thanks so much...I'm taking everyones advice and just staying away from UNG. I'll just consider my early trades random luck of the draw.


On Aug 22 01:42 AM Vikram Saxena wrote:

> William,
> The problem with UNG is the contango roll costs. You can look up
> the forward curve for natural gas
> finance.yahoo.com/q/fc...
>
> The price for the January '10 is a full $2 above the price of the
> Oct '09 contract. This a lot more than the same spread next year;
> Jan '11 is just $1 above the price of the Oct'10. If you go further
> out, the difference between the Oct and the next Jan contract is
> even smaller (70-80c). So even if the price of Natural Gas rises
> in a few months, UNG investors will be short-changed since the forward
> curve is already pricing in the rise in the price of natural gas.
>
>
> Since UNG and other commodity funds have become very big players
> in the futures market the market games them. Plot NGV9-NGU9 and you
> notice that the spread went up from around 25c to 40c just as UNG
> was rolling over.
>
> In the short term the market is really depressed because storage
> is almost full since supply is not diminishing at the same rate as
> demand, thanks to new shale wells which have very high output initially.
> The September contract collapsed in pricing as it got close to expiration;
> there is the same risk even with the October contract. Over the past
> 4 weeks the spread between October and November contract has widened
> by almost 30c!
>
> Right now the premium to NAV for UNG is close to 14.2%. GAZ is relatively
> less pricey though its premium shot up as the news about GAZ not
> issuing more shares leaked out yesterday.
>
> What we need is a product like USL which has an equal weighted portfolio
> of contracts spread over an year. Such a fund can capture the structural
> moves in the pricing of natural gas. Right now UNG is just a proxy
> of the front month contract.

Aug 22 04:21 PM